The Fair Tax and its big break for the $200,000-plus crowd

[I]f you're for a Fair Tax or any other kind of flat-rate tax, you are for shifting some of the tax burden from high earners to the middle class. There's really no way around that.

Exactly. That's a very basic point, but it's amazing how often it gets obscured in these debates.

A minor point of punctuation, but isn't it "FairTax" (no space) not "Fair Tax"?

Yeah, they write it "FairTax." But I believe we have spaces between words for a reason, and therefore refuse to go along.

The rest of that Brad DeLong link is well worth reading. A longer, spot on quote on the politics of the FairTax:

Does the FairTax make political sense? It is hard to see how -- at least not if people know what he is really proposing. After all, a lot more people make between $30,000 and $200,000 a year than make more than $200,000. Politicians prefer, other things being equal, to take positions that are advantageous to more people rather than those that are advantageous to fewer.

So why is Huckabee doing this?

I believe the reason is that he is counting on people not knowing what he is really promising. I believe he is counting on the nigh total fecklessness of America's press corps -- a fecklessness that I at least now see as deployed with a sharp partisan edge. As economist John Irons laments on his blog, ArgMax.com: "I'm not sure how he is getting away with adopting the FairTax as part of his platform. Wouldn't Democrats be skewered in the media if they proposed a tax increase on people making between $30,000 and $200,000?" Yes.

But Huckabee is a Republican. And it is different if you are a Republican...

DeLong goes on to quote the New York Times' pathetic "views differ" coverage on Huckabee and the FairTax.

A key point in all this is one shouldn't be too tough on Huckabee and the FairTaxers, at least not relative to the rest of the GOP field. As DeLong writes:

Is Huckabee's FairTax smoke and mirrors? Yes. Is it voodoo economics? Yes. But remember one more thing: It is more reality based than the proposals of the establishment Republican candidates.

We need to grade on a curve here. As Justin has documented, the other GOP majors -- even Saint McCain to say nothing of Giuliani and Romney -- or on record as saying they believe that tax cuts (and in particular the Bush tax cuts) increase revenues. The FairTax looks almost plausible by comparison.

I would disagree with the argument that shifting from income to consumption taxes is necessarily regressive. Obviously the models on offer in the current US debate do imply a shift in the tax burden to some degree, but there have been progressive consumption tax models proposed. I'm familiar with one in particular out of Canada, by a grizzled liberal thinker named Tom Kent - he published it through a think tank called the Caledon Institute back in 2003. He envisioned a taxation model that measures income against expenditure (basically your tax form becomes a general tally of cash flow, or at last the difference between revenues and net savings), and applies tax based on a household's yearly expenditures - but with exemptions built in at the low end, progressive taxation rates for high-spending households, and incentives for asset-building and saving.

It's complicated as hell - one wonders if it's workable (I'm not an economist). And it's obviously not what the guys at FairTax have in mind. But I think, given what we've seen over the past ten years in terms of the pattern of household spending versus saving (both US and Canadian households are highly leveraged in terms of borrowing - although Canada hasn't relied on mortgage refinancing to fuel its spending to the extent the US has - that Noth American voters (particularly in the US) would be increasingly open to a debate over policies to help families build savings and reduce reliance on borrowing.

Arnold Kling:
Our current tax system takes its biggest bite out of people who earn much more than they consume.

Really? Who is the archetype of an American who earns much more than he consumes if not Warren Buffett? Yet, at least according to Buffett himself, he pays a lower tax rate than his receptionist.

Or look at it a different way: The tax rate on dividend and capital gains is now just 15% even if you're making millions a year. So if you compare someone making millions a year in dividends and cap gains from investments, they will pay a lower tax rate than a typical member of the middle class who gets most of his income from salary on which he pays income tax and payroll taxes.

But I believe we have spaces between words for a reason, and therefore refuse to go along.

So says Justin Fox, valiant defender of traditional punctuation.

@Crust: Yeah, Kling's phrasing is a little off there. The reality is that our current federal tax system gets a big chunk of its revenue from people who earn much more than they consume. Also, Bush's cuts in dividend and capital gains rates were seen by the economists in his administration as a move in the direction of the flat/fair tax model.

@d. andy jette: I'm printing out Kent's paper right now. Thanks for the tip!

Re: the Kent paper, I don't want to overstate it's value as a technical paper; it's not a technical paper. It's also somewhat of a period piece, written at a time when the Liberal government of the day was struggling to find direction before ultimately finding itself in an election in June of 2004. But I've always been intrigued by the proposal, even if it never gained much traction policy circles - in late 2004 at a social policy conference in Montreal I had the opportunity to ask Kent (he was the opening day keynote, speaking on another topic) about his tax paper, and he responded by saying I was one of the only people to ever ask him about it in a public forum.

I'm curious as to whether the idea of a progressive consumption, whether as envisioned by Kent or otherwise, is practical, or desirable as an alternative to sales taxes and or high income taxes.

The arguments for and against taxing consumption, regardless of how it is accomplished, must also consider the often-unintended impact of simple human nature. Aside from the general concerns that taxpayers would attempt to circumvent the tax, our present economy is predicated upon continued spending (not saving and investing - which is another topic altogether) by consumers. It can be anticipated that a consumption tax would lead consumers to reverse their decades-long love-affair with "throw-away" consumer products that we import from all over the world and sell at our "big-box" and other retail outlets. As admirable as it might be to actually decide to "repair" broken products, or to encourage the manufacture of "higher-quality" products in the first place (a result which would naturally occur if people feared purchasing new items because of the tax assessment on 'sales'), the economic losses to our economy would likely never be made up by the much-touted economic release envisioned by the Fair Tax supporters expected to result from freeing consumers from confiscatory taxation (not to mention that States would still be free to impose income and other taxes in order to fund their economies!!). Our national manufacturing base is going the way of our agricultural base. We are a nation of consumers. While taxing over-consumption (however defined) may have a certain appeal, it makes little sense to move away from a system which - over time - has removed vast numbers of individuals from having to file tax returns - to a system in which every individual - in one way or another - will be impacted by the tax system (even if just to receive a check from the government - a task which is far from error-free even today!). It would seem to make far more sense to modify our current tax system to eliminate the need for more folks to file tax returns (e.g. simplification) by expanding the Standard Deduction, re-creating socially desireable deductions for mortgage interest and charities as tax credits, allowing full above-the-line deductibility for medical expenses and casualty losses and certainly imposing a surtax on income over, say, $250,000 for a family (along with phasing out other tax benefits and making Social Security Income fully taxable and removing the limit on withholdings for FICA). Anyway, there are many things that can be done to "flatten" the current tax, but the Fair Tax is probably NOT one of them!!

One HUGE thing that seems to have been missed in this particular FairTax debate is the issue of power in Washington. The FairTax, as written would be an enormous power shift AWAY from Washington. No longer could there be favors given in the monstrosity that is our current tax code. Along with that power leaving DC, so will a good percentage of lobbyists, and corruption. The only real way to stem the corruption in Washington is to relieve it of much of its power. After all, if the federal government actually was held to the powers given it in the constitution, there would not be much need to lobbyists, as there would not be all that much going on in Washington…at least on the domestic front.

I understand that this can actually be an argument against the FairTax…as most politicians don't go through the trouble of getting elected, just to give away that power, but, if the American people can be sufficiently persuaded, it can be done.

Finally, try arguing the reverse. Pretend that you are talking to a 30 year old, who has only, ever known the FairTax. Try convincing him of the advantages of our current system, and that we should move to that model.. Good luck with that.

I am curious as to why so many are defending the current tax system??
Also, where's the discussion about the $$ saved by Americans not having to shell out money to have their taxes done, the hundreds of millions from folks who cheat and, the hundreds of millions collected from the underground economy??

htowner,

Because your points are irrelevant ($$ saved on tax prep is far less than money lost), untrue (100's of millions don't cheat on income taxes), and irrelevant again (it's arguable that the underground economy is taxed when "business owners" in that economy themselves purchase goods and services in the open market (whose profits are taxed).

How stupid do you think we are?

You're cleverly leaving out the rebate.

Let's say for simplicity that $20k/yr is the poverty line for singles, and that our two examples are single men.

Man A makes $30k/yr and spends $30k/yr. He pays $2300 in FairTax. 23% of 30k is 6900, but his rebate checks cover 23% of the first $20k, so that nets to $2300, or 23% of $10k.

Man B makes $200k/yr and spends $50k/yr- only a quarter of his annual income. He too gets a rebate check. 23% of $50k/yr is $11,500, his rebate covers the first $4600 in FairTax, making his total tax bill for the year $6900, which is $4600 more than Man A.

I guess liberals can't do math.

"I am curious as to why so many are defending the current tax system?? "

Because we have zero faith that a new tax system would be immune to the pressures our current one is. We need the IRS to enforce the current tax law, and a new tax method wouldn't change that. Unless we trust that business will self report their taxes properly, or won't sell products under the table in cash.

Secondly, the special interest groups will start to get all types of exceptions and deductions for their products. Or certain activities (home rebate, buying a car this year etc.) will warrant a larger rebate. Our problem isn't that the idea behind our taxes is difficult, it's that a lot of deductions and rebates have been added to the tax code.

The "prebate" is irrelevant. Here's why:

The current US economy is primarily driven by consumer spending. That means we need to understand how people will behave in order to predict the effect of a national sales tax.

Knowing that...

1) Prices of goods and services are set at what the market will bear (income taxes play little to no role).Ergo, prices at the register will rise and people will notice that (it'll be hard not to).

2) People generally respond to stimuli that are most salient (i.e., at the forefront of their thoughts) in the environment. That means the "prebate" will not factor into purchasing behavior because prices at the register will be far more salient to consumers

The most obvious conclusion is that a national sales tax will drive down purchases. Spending will drop no matter what, regardless of a prebate (this will be especially true in the middle class who will not receive the prebate). Consequently, the economy will tank.

Okay, so the economy will tank, which is still debate-able, but I'll concede for simplicity.

You still skipped right past the fact that as the richer man makes more, he spends more, which means he pays more in taxes. As opposed to paying less, as in the "big break for the 200k crowd" and trying to trick us littles into thinking we're paying for it.

Waa? I just re-read- how does the middle class not receive the prebate? Everyone receives the prebate.

The economists who support the Fair Tax (or Steve Forbes's flat tax or any other tax change that would shift the burden from income to consumption) believe that money saved and invested is worth far more to the economy than money consumed. People who make $200,000 a year tend to save a much higher percentage of their income than people who make $30,000. Therefore, giving those high earners a tax cut would mean even more saving and investment, which would mean more economic growth. That's the thinking. It's certainly not universally shared among economists, but neither is it some crazy fringe idea.

what's crazy is that its not a fringe idea

the basic theory is that when you decrease taxes that go into "savings and investment", you contribute to economic growth.

Which may be true when the government isn't already running a deficit, but simple logic tells you that can't be true when the government has to borrow to "pay" for the tax cut, because for every extra dollar you make available for "savings and investment", you are creating a demand for a dollar of that capital by the government. You haven't really increased the pool of capital available for investment in "private sector economic growth" at all.

In a true market based economy, there is no need for government incentives for capital growth. When the benefits/costs/risks calculation of a proposed investment outweigh the benefits/costs/risks calculation of an existing investment, the existing investment will be sold, and the proceeds will go into the new investment.

Moreover, adding money to the investment pool when there is no need for new capital simply leads to asset inflation --- and the creation of bubbles that eventually burst and highly speculative investments that don't pay off.

The bottom line is that in economic terms, the "Fair Tax" is simply stupid economically --- because it will reduce consumption and demand, thereby reducing the need for labor, while also reducing the need for investment that contributes to economic growth and leading to asset inflation.

Like I said -- the whole thing might not be a fringe idea, but that don't mean it ain't crazy.

verybadcat, I'm not sure who you're replying to but in any event according to your own numbers Man A making $30k/year has a tax rate of 7.7% and Man B making $200k/year has a tax rate of 2.3%. So the man making more -- though he is of course paying more dollars in tax -- is paying a lower tax rate. Certainly, 2.3% would -- as DeLong and Fox say -- represent a huge tax cut versus the current system for a typical person making $200K.

Furthermore, as of 2006, the poverty level for a single person was $10,488 not $20,000. So in reality the tax burden on the single making $30K would be roughly double what you say.

Has it occurred to any one that goods produced in the United States bear an unfair tax burden that goods imported from other countries do not.
goods produced in the United States would cost the same because the tax is shifted from the front to the back end. Imported goods would cost more thus making American industries more cost competitive when the goods are consumed in our own country.

Waa? I just re-read- how does the middle class not receive the prebate? Everyone receives the prebate.

The middle-class -- and everyone else -- would get the prebate. The point is that accounting for everything (including the prebate) the total tax burden for the middle class would go up under the FairTax (or Steve Forbes' flat tax). You may think that's a feature or a bug; either way, it is a reality.

I'm a fan of changing the status quo in our current America on many levels and the FairTax seemed to be the best vehicle for tax reform when I first learned of it 5yrs ago or so. While, it's not a perfect plan - none ever are perfect - it's a good plan based on leveling the playing field as much as possible, eliminating the grotesque tax code and providing an opportunity to divert the power held in DC back to the people. Anything that can do this, while inspiring regular Americans to shake off their apathy and get involved make this a winner in my book!

My main concern is that there is a large contengency of journalists writing articles under the guise of "fair reporting" on the FairTax that really have not taken the time to do proper research to understand the plan and then present it correctly. Bartlett is one of those who amazes me in his omission of large facts, concepts and figures regarding the FairTax. These are blatent hit pieces, that in this era of internet fact checking, should be pointed out with a white-hot spotlight - whether you are a friend of the plan or not. All I ask is for folks like Mr. Fox here continue to show the good the bad and the ugly in the pursuit of truth vs. an agenda. (Very good job here Justin)

Let's continue to debate and poke holes into this and any other reform plan that surfaces, but after 5yrs of research and discussion The FairTax is still my current #1 girl at the dance.

You still skipped right past the fact that as the richer man makes more, he spends more, which means he pays more in taxes.

ah yes, its the Paris Hilton school of economics (the school that says that there is no distinction between wealth and profligacy) rearing its ugly head again.

Its my second favorite school of economic thought, right after the Mother Theresa school (the one that says that that every dollar taken out of government services for the poor and given to the rich will not merely find its way into the hands of private charities, but the private charities that are specifically designed to help the poor people that the government just cut out --- and because they are private charities, they'll be more efficient!)

In the real world, the Fair Tax will reduce consumption -- even among those making "only" 200K a year -- because anytime you increase the price of something, the demand for that item goes down... So even someone making 200K is gonna look at the price tag of that Jaguar, and say "do I really need a third car?"

Correction: It was my understanding only those below the poverty line receive the prebate.

Verybadcat, you're clearly unfamiliar with the idea of diminishing returns.

There're only so many things you will spend money on. I'd have to check but the largest expenditures in the consumer market (which is all that the proposed "Fair" Tax covers) are "everyday" items (e.g., gasoline, food, clothes) as opposed to "big ticket" items (e.g., homes, cars, boats). There are only so many big ticket items a single household will purchase and those tend to be extremely durable goods (especially when you have more money).

In other words, the relationship between income and expediture in nonlinear. Specifically, think of it as similar to a curve that approaches infinity (though with different numbers). It may be "more" as defined by a higher raw number, but when you compare the percentage of income that would go to taxes it would be radically different. With percent of income in mind, a national sales tax clearly shifts the burden to the lower and middle classes, who spend a far higher proportion of their income on goods and services than do the upper classes.

However, it is the upper classes who use far more of the commons than the lower and middle classes (but that's another argument against the FT).